Insurance companies offer annuities as tax-deferred alternatives to mutual funds or other taxable investments. To purchase an annuity, the owner pays a premium to the insurance company, and after paying the premium, there is usually no other monies due from the owner to the insurance company. Because an insurance company provides the annuity, certain insurance benefits can become a part of the annuity contract. The annuity can be thought of as two products in one—a deferred product and a payout product.
Annuities provide the owner with the right to “annuitize”. This is the payout phase and it ensures the owner of the annuity, or their designee, the right to exchange their current investment in the annuity for the right to receive monthly payments for the rest of their life. This right to annuitize is an insurance element in the annuity, since the number of monthly payments will be based on the future life expectancy of the owner.
In the deferral phase, which precedes the payout phase, the owner of the annuity has a contract that looks a lot like an investment. The premium is invested on their behalf by the insurance company, and the owner's investment usually increases in value with time (on a tax deferred basis). If necessary, the owner can withdraw all or part of the investment at a later date. If all of the investment is withdrawn, the contract terminates and the insurance company has no further obligation to the owner of the terminated annuity.
Some annuities are fixed annuities, which means the insurance company promises a fixed investment return on the premium paid by the owner. The owner cannot lose money on the investment. Other annuities are variable annuities, which means the owner of the annuity determines how the premium is to be invested. Often, under a variable annuity, the investment choices are not guaranteed, and the owner's investment (called an account value) could lose value in time. Because the variable annuity has fewer guarantees than a fixed annuity, insurance companies often provide more insurance elements in a variable annuity.
Almost all variable annuities offer the owner a guaranteed minimum death benefit (GMDB). This insurance feature promises that if the owner dies while the annuity is in the deferral phase, the beneficiary will receive a guaranteed amount of death benefit regardless of the value of the account value prior to the owner's death. This feature has been a comfort to many annuity owners, since they know that their account value could fluctuate broadly with changes in the financial world. Each insurance company can offer a different type of GMDB, and sometimes charge extra for it, based on their niche within the marketplace.
The insurance element of variable annuities led to the development of a reinsurance market for these risks in the past decade. Insurance companies that write variable annuities want to manage assets, and reduce the risk of surprises when it comes to their earnings on these assets. Unfortunately, the GMDB presented the possibility of earnings surprises, since the benefits paid would not only depend on how the investments performed, but also on the mortality of the owners.
The insurance companies attempted to reduce the risk by reinsuring some or all of their variable annuities with GMDB. However, the reinsurance market did not accept this risk quickly, because the risk was heavily affected by changes in the investment vehicles, such as the stock market. By the mid 1990's, however, many reinsurers had assumed some GMDB risk, and two or three were actively seeking out GMDB reinsurance business.
The design of reinsurance programs for GMDB followed a similar pattern regardless of which company provided the reinsurance. In exchange for a reinsurance premium from an insurance company, the reinsurer would cover the losses of the insurance company. The reinsurance premium was typically directly based on the account values of the variable annuities being reinsured. The premium would be paid by the insurance company monthly or quarterly for as long as the variable annuity remained in the deferral phase. Reinsurance losses were usually defined as the GMDB less the account value, if positive, for any owner that died.
The reinsurers knew that they would make money (premiums would exceed losses) almost all the time, but they also knew there could be some calamitous periods where they lost a lot of money (e.g. stock market crash, oil embargo, etc.). Because this traditional reinsurance of the GMDB in a variable annuity is considered fairly risky, comparatively few reinsurers are providing this type of product.
Accordingly, it is an object of the present invention to address one or more of the foregoing disadvantages and drawbacks of the prior art.
It is a further object of the present invention to provide methods and apparatus for quantifying, controlling and limiting monetary risk for the insurer writing variable annuities with GMDB and the reinsurer.